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By | October 2012
Page 1 of 26

Basis of Exchange
In modern world, almost everyone of us specializes in the production of some goods and services and then use what we produce to exchange for something that we do not produce. YAO Ming specializes as basketball player; Thomas FRIEDMAN specializes as a prominent writer; Bill Gates specializes in the development of Windows operating system; Ms. Wu Yi specialized as a vice-premier of the State Council of the People's Republic of China from 2003 to 2008. Take Ms. Wu Yi, as an example. One would expect that Ms. Wu Yi, like any Chinese women of her cohort, was capable of doing household chores. Then, would we expect Ms. Wu Yi to be doing her household chores during the years when she was a vice-premier? Should she? Most of us would say no because she had much more important things to attend than household chores. The statement that she has much more important things to attend than household chores is another way of saying her opportunity cost of doing household chores is too high (higher than the benet of doing household chores). Someone would have attended the household chore for her. Yes, this is a specialization. To allow for such specialization, exchange is inevitable. Why do we specialize and exchange, to begin with? If all decisions are voluntary, it must be the case that such arrangement of specialization and exchange improves the well-being of all parties concerned.

2.1. Absolute advantage and comparative advantage
Consider Robinson Crusoe and Friday who lives on an island. There are only two production activities available: Coconut gathering and shing. summarized below. Suppose the time required by each to gather a coconut or to catch a sh is

Crusoe Friday

3 hours 2 hours

4 hours 1 hour

We can easily see that Friday takes less time to gather a coconut than Crusoe. In economics jargon, we say Friday has an absolute advantage over Crusoe at the production (or gathering) of coconut. Similarly, we...